FDL Book Salon: Capitalism Hits the Fan: The Global Economic Meltdown and What to Do About It

[As a courtesy to our guests, please keep comments to the book. Please take other conversations to a previous thread. – bev]

Dr. Richard D. Wolff is a prominent Marxist economist who teaches at U. Mass and The New School. The book is composed of scores of short essays he did for Monthly Review beginning in 2005. The publicity blurb sent to potential reviewers states that Dr. Wolff “predicted the economic meltdown years ago.” The book does not contain specific predictions of the meltdown beyond the omnipresent Marxist prediction that capitalism is inherently unstable. Dr. Wolff’s articles take note of the bubble and nonprime assets in the articles in the book after the collapse of the bubble and after the crisis in nonprime assets were obvious. Readers interested in the scholars that predicted the specific crisis should consult Jamie Galbraith’s article.

Dr. Wolff’s emphasis is explaining his overall Marxist critique of capitalism’s defects. The articles can be read easily by the general reader. No economic expertise is required and Dr. Wolff writes in English without the Marxist jargon that non-specialists find confusing.

Dr. Wolff’s Theses

Capitalism inherently causes crises. The crisis manifested itself in finance, but was not caused by finance. The crisis arose on Main Street. Capitalism creates inherent class conflicts (though Dr. Wolff is known for rejecting a deterministic view of class). Capitalists seize surplus value that is produced by the workers. In the U.S., rising productivity allowed over 150 years of increasing wages. After 1970, while productivity continued to grow, real wages stopped increasing. Income inequality, which had long been increasing, soared. As the elites grew ever more dominant economically, their political hegemony also soared.

Capitalism never worked in the U.S. Developments that other scholars have praised, e.g., the massive increase in U.S. food production, brought corporate farming, pollution, and excessive energy use. The “things” we have (houses, cars, TVs, computers, Getc.) evidence our morally (and eventually financially) bankrupt consumerism. The consumerism leads us to lead empty lives overwhelmed by stress and physical exhaustion.

As real wages stalled and consumerism increased, Americans sought to maintain their standard of living by going ever deeper into debt. This created an opportunity for finance capitalists to obtain extreme profits and meant that the loans to the financially overstressed borrowers would eventually default. Dr. Wolff also appears to see this process as inflating bubbles.

Dr. Wolff’s solution is to avoid what he sees as “the left’s” strategy failures during the Great Depression. The left sought to save capitalism through regulatory rather than destroy it. Regulation, however, can never restrain capitalism because capitalism provides the capitalists with the riches that allow them to defeat regulation. The capitalists began by evading FDR’s New Deal reforms. As they gained increased power and discredited the government and regulation the capitalists were able to use deregulation, privatization, and desupervision to destroy regulation. Capitalism always trumps regulation. The solution is for workers to own the businesses and elect the board of directors.

His views on Women and Immigrants

Dr. Wolff returns repeatedly to claims about women and immigrants. First, capitalists induced women and immigrants to enter the U.S. workforce in order to reduce wages. (The rabidly anti-immigrant VDare site includes a blog by a rabidly anti-Marxist writer enthusing about Dr. Wolff’s claims that Capitalists caused high immigration as a means of reducing wages.) Second, the entry of women into the workforce has had terrible effects on the family.

With their living standards and relative social positions thus threatened, most American families sent more household members out to work. *** The resulting exhaustion, interpersonal tensions, and financial anxieties yielded crises of divorce, alienation, depression, drug dependence, and abuse (p. 9; see also p. 41).

[Americans] simply kept on buying more commodities. To pay for them, workers took on more hours of labor and borrowed vast sums. Worker exhaustion rose accordingly, likewise the number of family members sent out to work (straining “family values” to the breaking point) (p. 53).

By outsourcing jobs overseas to take advantage of cheaper wages, by drawing US women into the labor force, by substituting computers and other machines for workers, and by bringing in low-wage immigrants, employers drove down their employees’ wages even as they produced more commodities for sale (p. 75).

June Carbone (UMKC Law) is my spouse of nearly 31 years, and she is a family law scholar. Firedoglake regulars may recall that she and Naomi Cahn recently authored Red Families v. Blue Families. June authored an earlier book, From Partners to Parents, which refuted Gary Becker’s criticisms of the increased entry of women into the paid workforce. Becker claimed that the entry of women into the paid workforce reduced specialization. Husbands specialized in men’s work (for which they got paid) and wives “specialized” in working inside the home (for which they did not get paid). Becker claimed this “specialization” was essential to maximizing efficiency. He recommended against providing advanced educational skills to females. Yep, he thought Yemen was the model of economic efficiency. The Nobel committee was particularly enamored of Becker’s nonsense about women. I am channeling June and Naomi’s findings in my comments about the increasing entry of women into the paid workforce.

The data contradict Dr. Wolff’s claims that the increasing entry of women into the paid workforce is destroying families. He is correct that Americans work extremely hard. But “wives” is not the relevant category. Women are a majority of college graduates. Large numbers of American women have college degrees. Women with college degrees overwhelmingly wish to work in the paid workforce and are happy to be employed. They generally find such work fulfilling. While the hours they work have increased materially, the divorce rate for couples that are college graduates has fallen sharply and is now back to the rate in 1960. Indeed, this pattern is one of the reasons why income inequality has increased. Getting married, and staying married, to a fellow college graduate is an excellent strategy for building income and wealth. Some of these couples become “Capitalists,” or petit bourgeois but many form the core of the salaried middle class and upper-middle class.

The divorce rate surged in the late 1950s and 1960s even as women that had worked during World War II withdrew (or were pushed) out of the paid workforce. This surge in the divorce rate occurred even though the average workweek was lower in the 1950s and 1960s than shortly before the Great Recession even though female paid employment (as a percentage of total employment) fell immediately after the war.

Women with more “traditional” values who do not wish to be in the paid workforce but are married to men that cannot make enough money to support them are extremely unhappy. They are much more prone to divorce.

Employers (and unions) generally had to be dragged screaming and kicking into hiring women for jobs that were traditionally viewed as male. That’s why Title VII of the Civil Rights Act of 1964 was critical to opening up such jobs. Title VII was opposed by unions and employers.

But there are two more general problems with Dr. Wolff’s opposition to the increased entry of women into the paid workforce. More workers do not necessarily mean lower wages. The entry of workers can expand the economy and increase wages. One of America’s key economic, political, and social advantages over Yemen is this nation’s support for women’s rights. And the obvious question: what exactly does Dr. Wolff propose to do convince more women to leave the paid workplace? If the answer is that all workers should receive much higher wages, the question still arises: why should women be the ones to leave the paid workplace?

Even Marxists are unduly Kind to the “Control Frauds”

Dr. Wolff believes that “Capitalists” and the inherent nature of capitalism caused the crisis. He argues that it was non-financial corporations that drove the crisis. Wall Street became so large only because Main Street reduced workers’ wages and fed consumerism. The combination caused workers to borrow heavily to fund their purchases, which enriched financial firms.

Dr. Wolff’s articles vary in what they stress, but his dominant theme is that financial firms acted as they did during the crisis as a means of enriching the Capitalists (shareholders). Investors and lenders underestimated the risk of lending to subprime borrowers (p. 64) due to “irrational capitalist exuberance” (p. 85). This led to a bubble. When the bubble collapsed it caused the Great Recession. Dr. Wolff repeatedly states that all of this was extremely profitable to the shareholders of financial firms.

But elsewhere, Dr. Wolff notes that all of this was exceptionally unprofitable for investors and creditors. Indeed, fears of fraudulently overvalued assets were so great that massive financial firms collapsed. Trust dissolved and markets “froze” (p. 85). He notes that because financial firms knew about the true risks of nonprime mortgages and collateralized debt obligations (CDOs) (financial derivatives whose value depends on nonprime mortgages), they deliberately created a Gresham’s dynamic (when bad ethics produces a competitive advantage the ethical are driven from the marketplace) by placing the rating agencies in competition to secure grotesquely inflated (AAA) ratings (pp. 76-77, 115).

By late 2006, “liar’s loans” became roughly 40% of new mortgage originations in the U.S. Every study shows that liar’s loans are endemically fraudulent. A lender that does not underwrite a major loan creates intense “adverse selection.” The expected value of lending under conditions of adverse selection is negative. The lender will lose money. The FBI began warning that there was an “epidemic” of mortgage fraud in September 2004. The FBI estimates that 80% of the losses from mortgage fraud occur when lender personnel are involved in the fraud. The question that we must answer is why enormous sections of one of the largest industries in the world would lend under conditions that were certain to create severe losses?

The CEOs of nonprime lending specialists did not act to benefit “Capitalists” (shareholders). They acted to benefit themselves – and the best way to do that was to harm the capitalists (the shareholders and the creditors). Dr. Wolff misses this central fact.

No conspiracy was needed to produce the real estate bubble, nor its current, devastating implosion. Just the normal workings of profit-driven markets sufficed to do the job (p. 115).

How quickly we forget – in the prior paragraph Dr. Wolff writes:

Profit-driven mortgage brokers greatly increased the number of home mortgages. Profit-driven banks saw huge fees in converting these mortgages into securities and selling them to investors in financial markets around the world. To do that, the banks entered the market for security ratings and paid the providers of these, corporations like Moody’s and Standard and Poor’s, to supply high ratings. The rating companies complied and made huge profits in that market.

This paragraph describes multiple conspiracies. He states that Moody’s and S&P sold their reputation. The issuers put them in competition and paid “huge profits” to the rating agencies as long as they were willing to rate paper that wasn’t even single “C” as pristine “AAA.” We need to distinguish between real and fictional profits and honest and fraudulent profits. The mortgage brokers are a prime example of the need for clarity. They were the ones that typically found the nonprime applicants for the fraudulent nonprime lenders. In the typical case the loan broker aided and abetted the lender’s fraud in four ways. It was the broker’s personnel that knew the lender’s lending requirements (which the lender wished to evade, but appear to comply with). The broker typically put his personnel on a salary based primarily on commissions tied to loan volume – with no requirement for loan quality. Such a compensation system creates strong incentives for the broker to engage in mortgage fraud. These loans create fictional accounting profits and real losses. They only produce profits if the people originating the fraudulent loans are able to sell them. They can only sell them if they can induce the rating agencies to give AAA ratings to CDOs backed by endemically fraudulent loans. If they are able to sell the fraudulent loans by suborning professionals, then they obtain a real, but fraudulent, profit.

Theoclassical economists made the naïve claim that “accounting control fraud” was impossible under capitalism. “Control fraud” occurs when the individuals that control seemingly legitimate entities use them as a “weapon” to defraud. Theoclassical economists’ creed was that markets were inherently “efficient.” Markets cannot be efficient if they allow material fraud. Therefore, theoclassical economists knew that inerrant markets prevented accounting control fraud.

Financial control frauds’ “weapon of choice” is accounting. Financial regulators, economists, and criminologists agree that accounting control fraud is a “sure thing” for a financial firm. The title of George Akerlof and Paul Romers’s classic 1993 article captures the perverse dynamic – Looting: Bankruptcy for Profit. The recipe for a financial firm optimizing fraudulent accounting income has four ingredients:

This recipe produces guaranteed, record (fictional) profits and massive (real) losses. Modern executive compensation means that the senior executives that control the firm are guaranteed to become wealthy because of the huge, albeit fictional, profits.

The primary intended victims of accounting control fraud are the shareholders and the creditors – the capitalists. The workers may gain for several years. Control frauds seek to suborn everyone that can be helpful (by aiding the accounting fraud) or harmful (by blowing the whistle on the fraud – the primary means in the U.S. by which we discover insider fraud). Eventually, the workers may lose their jobs when the firm fails and may become merely creditors.

The crises that drove the Great Recession occurred in the financial sector because it was the most criminogenic environment available – and entry was easy. The ideal environment for accounting control fraud includes these factors (which characterize the finance industry):

Control fraud epidemics can hyper-inflate financial bubbles, which allows loan losses to be hidden through refinancing.

There are vital differences between the actual crisis and Marxist theory. The fact that the managers that controlled the nonprime lenders defrauded the capitalists (shareholders and creditors) and other capitalist firms to whom they sold liar’s loans on the basis of fraudulent “reps and warranties” is not consistent with classic Marxist theory. The fact that the overwhelming majority of the nonprime specialty lenders failed because they made loans under conditions of extreme “adverse selection” (which produces a negative “expected value” of lending) is contrary to the fundamental Marxist theory that assumes that firms maximize real profits for the benefits of the capitalists by usurping “surplus” created by (and justly owing to) the workers. Accounting control fraud produced the ultimate violation of theoclassical economics dogma in nonprime lending. The genius of voluntary market transactions is supposed to be that both the seller and buyer are made better off (Pareto optimal). But the typical nonprime loan made in 2006 made both principals – the corporation (and its shareholders) that lent the money and the borrower – worse off. The “unfaithful agents” (the officers, appraisers, auditors, rating agencies, and attorneys) were enriched. This systematically perverse result is supposed to be impossible under capitalism’s precepts, but it is also not explained by Marxist theories. Capitalism’s most elite CEOs defrauded the capitalists – and were then bailed out by the government. The control frauds pretend to support capitalism, but that too is a fraud. They actually exemplify crony capitalism.

Marxists may find reading modern white-collar criminologists’ research useful. White-collar criminologists take class seriously. Indeed, Sutherland’s classic definition of white-collar crime drove Conservatives berserk because it stressed high social status. Control fraud theory focuses on the most elite frauds and explains how they use their status and economic power to manipulate regulators and legislators. Much of this work would support key aspects of Dr. Wolff’s theories.

Control fraud, however, is not unique to capitalism. It is common in the public sector. In some nations (kleptocracies) it is the norm in the public sector. It exists in the non-profit sector (such as the Baptist Foundation of Arizona – a form of “affinity fraud” targeting the faithful) and in for-profit firms that are owned in mutual (v. shareholder) form. It exists in unions. In some nations, NGOs are often governed by frauds. The people that control the seemingly legitimate entity often use that control to benefit themselves at the expense of the entity and those the entity is supposed to benefit. I have discussed here only accounting control fraud, where the intended victims are the creditors and shareholders. There are anti-customer control frauds that maim and kill or cheat the consumer, anti-public control frauds (illegal disposal of toxic waste, cartels, and tax fraud), and anti-worker control frauds that steal wages or endanger lives.

[William K. Black is Associate Professor of Economics and Law at University of Missouri – Kansas City.]